The Daily Telegraph - Saturday - Money
Spend £32k for a 90pc saving by using pensions to cut inheritance tax bills
Savers passing down wealth could make a 90pc tax saving and cut inheritance tax bills at the same time using littleknown rules in the pensions system.
Funnelling money into a family member’s pension is one of the most efficient ways of reducing an estate for IHT purposes and comes with the added boost of income tax relief.
Pension contributions via a gift from family members attract tax relief at the marginal rate of income tax. If the recipient is not a taxpayer, contributions still benefit from the basic 20pc relief.
A gift of £ 32,000 would reduce IHT liability by £12,800. If the person receiving the money was a higher-rate taxpayer, they would receive £16,000 in tax relief, £8,000 to automatically go into the pension and £8,000 that could be claimed back through a tax return. This would result in a pension contribution of £40,000 and £8,000 in cash. The total tax savings on the £32,000 gift would be £ 28,800, or 90pc. Of course, income tax might be paid whenever the pension is finally withdrawn.
Anyone who pays into a pension receives tax relief, meaning that their contributions are effectively topped up by the taxpayer. Relief is granted at the saver’s “marginal” or highest rate, meaning people who earn more receive more.
Andrew Tu l ly of Canada Life, a pension provider, said: “Making lifetime gifts to family members by way of pension contributions is a little-known area of flexibility within pensions but from a tax perspective, is hugely efficient.”
However, there are a few restrictions for those considering making a gift in this way. Gifts are generally treated as “potentially exempt transfers”, which means that you can hand over an unlimited value without having to pay inheritance tax but you must live for another seven years after making the transfer. Failing that, at least part of the gift is added to the value of your estate and will be caught by IHT. The person receiving the sum of money must also have enough earnings that year to cover the size of the contributions. So if the gift results in a £40,000 contribution to their pension, they must have an income of at least £40,000 in the same tax year. Savers have an annual allowance, which means that most people can only pay up to £40,000 into their pensions each year with tax relief.